Eurozone

EU politicians have been locked in myopic and often self-defeating policies regarding bailout of troubled eurozone countries. They have insisted, in principle correctly, that troubled countries bring their finances to a sustainable path. But the austerity measures used are killing the growth prospects of these countries and damaging their ability to repay the lenders. The less able-to-pay the borrowers become, the tougher the repayment terms imposed, leading to a vicious cycle of further deterioration.

An alternative would be to tie the coupon paid on rescue loans to the growth of the country’s economy. When the economy is in recession, the debt interest burden will be lower, helping the country to boost growth; when economic growth picks up, GDP-linked payments will be higher precisely when the country can afford it. Read more

European court ruled that stability mechanism was not contrary to EU law. Image by Getty

By Professor Simon Deakin

Courts don’t often try to decide the direction of economic policy. However, in effect, this is what the European Court has recently done. In its Pringle judgment the court made a number of important decisions on the legality of bail-out policies being pursued by the European Union.

It ruled that the establishment of the European Stability Mechanism – the fund through which financial assistance will in future be channelled to eurozone states facing the possibility of bankruptcy – was not contrary to EU law. By implication, the ruling also supports the recent attempts by the European Central Bank to shore up the euro by buying the government bonds of debtor states on secondary markets (that is, buying them from commercial banks that have first purchased them from governments). Read more

The global economic recovery is on the ropes, battered by political conflicts within and across countries, lack of decisive policy actions, and governments’ inability to tackle deep-seated problems such as unsustainable public finances that are stifling growth. Growth in global trade has weakened and the spectre of currency wars, with countries looking to maintain export competitiveness by keeping their currencies weak, has returned to the fore.

The Brookings-FT Tiger index shows growth momentum has dissipated in nearly all major advanced and emerging market economies. Central banks of the major advanced economies have responded with a range of conventional and unconventional policy monetary policy actions. These measures have put a floor on short-term financial market risks but have been unable to reverse declining growth momentum. As a result, financial markets continue to go through short-term cycles of angst and euphoria even as indicators of real economic activity remain mired in weakness. Read more

It’s only money, for heaven’s sake! The euro is a great convenience for trade and travel, and it is a powerful symbol of unified purpose for countries that have been at each other’s throats for 1000 years. But it doesn’t cure cancer or the common cold. In October, Angela Merkel, German chancellor, said: “If the euro collapses, then Europe collapses.” This hyperbole may have worked as scare politics, but it was bad economics. Keynes identified as long ago as 1923 what we can now call the Merkel mistake:

“Conservative bankers regard it as more consonant with their cloth, and also as econo­mising thought, to shift public discussion of financial topics off the logical on to an alleged ‘moral’ plane, which means a realm of thought where vested interest can be triumphant over the common good without further debate.”

In the lead-up to the G20 summit in Los Cabos, the Brookings-FT Tiger index shows that this stop-and-go global recovery has stalled once again.

The engines of world growth are running out of steam while the trailing wagons are going off the rails. Emerging market economies are facing sharp slowdowns in growth while many advanced economies slip into recession.

Political fragmentation and gridlock have hurt confidence and stunted the effectiveness of macroeconomic policies. Financial markets have shed their optimism and investors are clamoring to retreat to safe havens as confidence has tumbled.

The US economy had been a relatively bright spot, although a fragile one, but growth is showing signs of slowing and employment growth has weakened even as the economy gets closer to an impending fiscal crunch. The UK and many of the eurozone economies are in or at the edge of recession. Even the once-mighty German economy seems to have lost its footing while Japan’s economy is stirring but remains mired in weak growth. Read more

The world economy is showing scattered signs of vigor but remains on life support, mostly provided by accommodative central banks. Concerns about spillover from a worsening of the European debt crisis and slowing growth in key emerging markets are putting a damper on consumer and business confidence. Equity markets are pulling back from a robust performance in the first quarter of this year as the sobering reality of a continued anemic recovery weakens investors’ optimism.

There are some positive signs in the latest update of the Brookings Institution-FT Tracking Indices for the Global Economic Recovery (TIGER), but also much to worry about as the world economy continues to meander with no clear sense of direction. Read more

Emerging markets have fallen victim to unstable capital flows in the wake of the financial crisis. In an attempt to mitigate the accompanying asset bubbles and exchange rate pressures that come with such volatility, a number of emerging markets resorted to capital controls. Although these actions have largely been supported by the International Monetary Fund, some policy-makers and economists have decried capital controls as protectionist measures that can cause spillovers that unduly harm other nations.

Recently-published research shows that these claims are unfounded. According to the new welfare economics of capital controls, unstable capital flows to emerging markets can be viewed as negative externalities on recipient countries. Therefore regulations on cross-border capital flows are tools to correct for market failures that can make markets work better and enhance growth, not worsen it. Read more

Following the unprecedented downgrade of the European Financial Stability Facility and nine eurozone sovereigns by Standard & Poor’s, there is a renewed impetus for the International Monetary Fund to step up its involvement in the deepening euro area crisis. In an executive board meeting earlier this week, managing director Christine Lagarde requested that the membership step up the fund’s own war chest in an effort to better equip the institution to adequately confront the growing global threat. The move follows an earlier reshuffle at the helm of the European department of the IMF, signalling that the fund has been quietly preparing itself for the gloomiest scenario in which the situation in Europe develops into a full-blown systemic crisis.

Credit: Hannelore Foerster/Bloomberg

Currently, the IMF is unable to ring-fence the euro area and contain any spillovers to the global financial system unless its global membership agrees to provide a significant boost to its resources. As it stands, the organisation has some $385bn in its forward commitment capacity, including the activation of the contingent facility — the new arrangements to borrow — that can be used “to cope with an impairment of the international monetary system or to deal with an exceptional situation that poses a threat to the stability of that system.” Read more

In his novel, The Jungle, the American muckraking author Upton Sinclair wrote about the horrendous work and sanitary conditions in the Chicago meat packing industry of the early 20th century. It is sometimes said Sinclair aimed for the heart but hit the stomach. That is because he aimed for progressive social and economic change, but instead his work prompted the founding of the Food and Drug Administration.

The same problem of missing the target confounds current discussions of the eurozone’s problems. What the euro lacks is a government banker, not a lender of last resort as is widely claimed. Read more

“The facts, ma’am, just the facts”: these words, attributed to the detective Joe Friday in the American 1950s crime series Dragnet, resonate in today’s eurozone crisis. Will anybody help Angela Merkel, German chancellor and a trained physicist with a sharp analytical mind, to get hold of the facts blurred by this misguided eurozone debate? Or must we wait for François Hollande, Socialist challenger for the French presidency, a European with hyper-sober realism, to grasp the facts his country’s president, Nicolas Sarkozy, has so far ignored? Read more

The eurozone‘s public finance crisis continues to fester, reflecting both political and intellectual failure. The intellectual failure is that the crisis has been interpreted exclusively as a debt crisis when it is also a central bank design crisis resulting from the euro’s flawed architecture. The flaw is the inability of eurozone governments to harness the central bank’s power to assist government finances. This systemic weakness explains why US and UK government bonds are weathering the storm, whereas Spain confronts default rumours despite having roughly similar debt and deficit profiles. Read more

Our analysis paints a sobering picture of worsening public debt dynamics and a sharply rising debt burden in advanced economies. These rising debt levels combined with heightened concerns about fiscal solvency now constitute a major threat to global financial stability.

Recent events in Greece, Ireland, Portugal and other economies on the periphery of the eurozone show the risks of debt buildups that are not tackled. Bond investors can quickly turn against a vulnerable country with high debt levels, leaving the country little breathing room to balance its fiscal books and precipitating a crisis.

Overall, the worldwide picture of government debt is not pretty. Read more

The agreement that eurozone leaders reached last week has succeeded in engaging the private sector in the Greek rescue. The package represents a sensible compromise: eurozone countries will provide some sort of guarantee for the collateral provided by Greek banks, which has been downgraded to default status. In turn, this will allow the European Central Bank to continue to refinance the Greek banking system, in keeping with its de facto role as lender of last resort which has led it to fill an institutional and political vacuum since the onset of the crisis. Read more

Although the European Summit reached agreement on how to develop the bail-out mechanism for sovereign countries after 2013, it was an agreement about process rather than content. Germany remained adamant that there would be no fiscal transfers to troubled economies, and that the best way forward is further fiscal consolidation, along with plans for the private sector to share in any losses after a sovereign default. EU finance ministers have been charged with filling in the blanks by 31 March, 2011 – if the markets are ready to wait that long. I am not confident that they will be. Nor do I believe that the present path is necessarily in the best interests of Germany itself, let alone other EU member states. Read more

A chorus of respected analysts is voicing pessimism about the future of the euro and the European Union.

Dani Rodrik writes about Thinking the Unthinkable in Europe. Barry Eichengreen comments on Europe’s Inevitable Haircut. Daniel Gros, in Big bang or endless crisis? argues for a big-bang solution to the eurozone’s problems. Ken Rogoff in The Euro at Mid-Crisis outlines an equally pessimistic scenario. Surprisingly, eternal optimists such as Desmond Lachman and Nouriel Roubini are joining the skeptics. Read more

The proposal to issue E-bonds, made in the FT by Jean-Claude Juncker and Giulio Tremonti, has sparked widespread controversy. Some observers (for example, Wolfgang Münchau) have said that it contains the kernel of a solution to the European debt crisis – which, under some circumstances, it might. But the initial response from Angela Merkel has been negative, exactly as it has been in many earlier rounds of this particular debate. The E-bond idea will obviously go nowhere without the support of Germany. But they have never before faced the real possibility that there could be a break-up of the euro if the sovereign debt crisis is not overcome. Maybe it is time for them to think again. Read more

The events of the last few weeks have shone a very harsh searchlight on the nature of sovereign debt within the European Monetary Union. Although critics of EMU have always argued that monetary union without fiscal union is “impossible”, it was only when Angela Merkel started to call for a procedure to handle a possible default on the sovereign debt of a member state that the markets began to focus on the fact that such a default really is possible. In substance, nothing much has changed with Mrs Merkel’s remarks: it always was possible for a sovereign state within the EMU to default. But now that the markets have realised that some key elements of “sovereignty” are missing from the EMU member states, market psychology has changed. It will be very hard to put this genie back into the bottle. Read more

The twists and turns in the European sovereign debt crisis have been more than usually bewildering in recent days, so I thought it would be useful to take a step back and look at the longer term budgetary fundamentals which will ultimately decide whether the troubled sovereigns in the eurozone can avoid default. The eurozone as a whole is in better fiscal shape than other developed economies (notably the US and Japan), and even the most indebted economies could yet dig themselves out of the hole they are in. But the eurozone is still plagued by the contradictions of trying to operate a monetary union without supporting this with a fiscal union.

It is becoming clear that these contradictions can only be solved if there is genuine burden sharing inside the eurozone, along with some much tougher budgetary and regulatory rules which prevent this situation ever happening again. Otherwise, there will be more discussion about default, on the lines of Nouriel Roubini’s piece in today’s FT. Or, in extremis, the currency union will be in real trouble. Read more

A conversation between Martin Wolf, the FT’s chief economic commentator, and Richard Haass of the Council on Foreign Relations, a leading US thinktank, on the eurozone crisis and its implications for the US and the rest of the global economy.